The Bear Case on Fitbit

It came as a surprise to most when Fitbit finally unveiled their financial numbers in their S-1. The company did over $700M in revenue last year (that’s over 10M devices sold!) and maintained an EBITDA margin of close to 26%. It was even more surprising how well FIT was received by public market investors. Fitbit’s  stock surged almost 60% on its opening day and has continued to outperform until its first earnings call. On August 5th, the company lowered revenue guidance and indicated that margins will decline in the next quarter, sending the stock down ~16% in after-hours trading.

Since I’ve been fairly bearish on FIT ever since its IPO, this bleak financial forecast did not come as a surprise. It seemed as if investors were so impressed by headline financial figures that they didn’t look further into Fitbit’s business metrics. FIT’s cumulative device sales track closely with registered users, which indicates that users rarely buy more than one device (despite Fitbit’s wide array of offerings). 

And, although 1 in 10 Americans owns a fitness tracker, research show that ~50% of them wind up in a drawer somewhere within six months. This kind of high user drop-off and low purchase repeat rate is a leading indicator of slowed growth down the line.

I’ve also always been skeptical of the product itself. Already, we have seen several startups, like Misfit and Moov, approach the wearables from the low end. In fact, you can buy a pretty decent activity tracker on mi.com (by Xiaomi) for $15! With Fitbit also victim of product recalls (the latest for the Fitbit Force in October 2014), it becomes clear that FIT will be subject to margin compression.

While Apple has indeed created general lift for wearables with the release of the Apple Watch, it has also set a price ceiling for these devices. For $350, you can get the lowest-end Apple Watch that does activity tracking on top of all its watch-specific apps… so why would you pay more than $300 or even $250 for a Fitbit?

Given these dynamics, Fitbit really runs the risk of becoming the Samsung of Wearables. While Samsung was able to grab a large share of the Android phone market a few years ago, the company has been slowly losing its footing to the likes of Apple and Xiaomi. Formerly the top mobile device maker in China and India, Samsung lost its footing in both crucial markets in the second quarter of 2014. How can it avoid this fate? Here are some suggestions:

  • Go Niche: Sometimes the right answer is a counter-intuitive one. Samsung failed in some cases because it flooded the market with a slew of low-end models – none of which appealed to the average consumer. Instead of trying to please everyone, Fitbit should take some of SoulCycle’s ethos and target a small and passionate niche. This may mean creating a Fitbit targeting fashion-forward women (a la Ringly), or creating a Fitbit for hardcore athletes (a la Athos). The wearables market will be large, but not necessarily homogeneous
  • Application and Service Integration: Samsung failed to build usable software and useful services on top of its hardware component. Samsung’s proprietary OS, Tizen, also never took off. I know Fitbit is incredibly focused on their consumer mobile app, which is performing well in the iOS and Google Play stores. The company has already made headway in this area by integrating more social and smartwatch-like functions to their fitness trackers, and should building the software and services layers.
  • Put Health First: Fitbit has proven its ability to make an activity tracker with a few bells and whistles. With the acquisition of FitStar, the challenge becomes making the app and wearable integration increasingly valuable to the user from a health-first perspective. In order to increase its unique value proposition and user retention, the Fitbit app should not only track activity, but find ways to increase and promote well-being.

The Emergence of “Pre-Seed” Capital

Notation Capital, founded by former Betaworks folks, is a new pre-seed investment fund launched a couple of months ago. 

Notation Capital is attempting to institutionalize the round of funding that’s usually done by “Friends and Family”. With just an idea and a co-founder, one could actually raise up to $500K in exchange for 5% to 10% of equity.

Really, pre-seed investing isn’t anything new. A few years ago, these rounds were simply known as seed or angel rounds, lead by early stage investors like SV Angel, Lerer Ventures, or Thrive Capital. Startup accelerator programs like TechStars and Y Combinator also use a similar model.

The thesis here is clear – firms are entering both from below and above the traditional VC-backed period of a startup lifecycle in hopes of capturing more of the returns generated by high growth companies. This is why we continue to see more large and institutionalized seed rounds (by pre-seed capital funds), as well as more large and highly-valued growth rounds (by public and/or PE funds). 

From a risk/reward perspective, I think funds with “bookend” strategies (either preceding or following the traditional VC funds) likely have lower return thresholds. What would be interesting is to see a partnership between very early and pre-IPO strategies – if one could be used to identify the winners and the other used for putting more capital behind those winners. 

Six Things Technology Has Made Insanely Cheap

I believe that technology and democratization goes hand-in-hand. If you examine the now-commoditized products listed in this article (PC, software, TV, trading commissions, camera, cell phone plan), you can also follow how such technologies became much more widespread and accessible to the masses as prices dropped.

The subtitle of the article boldly proclaims, “behold the power of American progress”! And it’s interesting to me that the author (Aki Ito) states:

For anyone bearish on the progress made by the U.S. economy, consider this: Computers are now one-1,100th of their price 35 years ago.

On the contrary, I believe that much of this price deflation actually comes from international manufacturers (read: China, India, etc.) who are able to produce virtually the same item at a fraction of the cost. 

With those two factors in mind, tech advancements and cost-efficient copycats, here are few things that I believe will face the same deflationary pressures over the next decade:

  • Mobile phones: This is a no-brainer and has already happened with the likes of cheaper Android handsets, courtesy of Xiaomi.
  • Automobiles and trucks: Asian manufacturers, such as Hyundai, are innovating quickly and will be able to rival Western brands soon in terms of quality. Furthermore, if Uber’s expansion continues world wide, demand for cheaper and more efficient cars will rise as drivers proliferate and riders opt to forgo car ownership. 
  • Education: With the current status of rising student debt, something’s gotta give. Disruptive Education Technology startups, such as General Assembly, Codecademy, and Coursera will begin to offer non-accredited alternatives to higher education. For profit education companies, like Minerva Project, will offer degrees at a fraction of what it costs today.
  • Food: I have high hopes for companies like Beyond Meat, who are looking to product petri dish-grown meat in a more cost-effective and environmentally sustainable way. Before that becomes mainstream, however, farmers will continue to lobby for government subsidies which hopefully will be passed through to consumers. 

On the other hand, there are a couple of things I wish would drop in prices, but I think unfortunately will continue to rise:

  • Healthcare:Healthcare is notoriously a laggard vertical when it comes to tech adoption, and the burden of outdated IT/infrastructure is eventually passed through to the consumer. An aging population, the impending shortage of doctors/nurses, and America’s sedentary lifestyle will all pose to be challenging to the current healthcare system. Without the right incentives for health systems and individual consumers to change their behavior, healthcare looks like it will only increase in the years to come. 
  • Housing: While this is a particularly stressful topic for those of us living in the Bay Area, I think it’s a pain point that all young adults will face sooner or later. Given high student debt and low employment, young adults will find it much more challenging to become home owners than the generation before did. 

What do you think will become cheaper or more expensive over the next decade?

Six Things Technology Has Made Insanely Cheap

Is 2015 The Year Legal Weed Changes The Future Of The American Economy?

I wrote an article on VC investing in the marijuana industry… a fun topic given how big and common weed is in the valley. Also an interesting topic to consider for all investors, in light of Neumann’s most recent blog post, where he claims, 

the only thing VCs can control that will improve their outcomes is having enough guts to bet on markets that don’t yet exist. Everything else is noise.

Is 2015 The Year Legal Weed Changes The Future Of The American Economy?

Robotics: the inevitable future

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Seen by its makers “more R2D2 than RoboCop,” the autonomous policing robot Knightscope K5 promises to patrol geo-fenced beats in hopes of reducing crime by 50 percent.

As a late-stage investor, I’m often waiting on the edge of my seat for technologies to mature to a point when IVP would typically get involved. For me, robotics is one of those exciting areas where I have to unfortunately sit on the sidelines, for now. 

Some quick thoughts on how robotics will develop over the next couple of years:

  • Forget the consumer angle (see: the Jetsons), as with other next-gen devices such as Google Glass, robotics will first find their plateau of productivity in the enterprise. (see: AMZN / Kiva Systems)
  • The future is friendly – robots should be made to look as innocuous as possible. (see: Eve from Wall-E)
  • Robots will not only replace human functions, but enhance them too. In the example of Knightscope, the robot can analyze data, such as hundreds of license plates, in a way much faster than a human can. In other words, go for a revenue-generating sales pitch, not just a cost-saving one. 

I have to admit that my understanding of robotics is still elementary Any suggested readings for me?

(PS. Speaking of Wall-E, this cruise ship is just missing those personal hovercrafts…)

Robotics: the inevitable future

Fundraising Acceleration as a Flawed Paradigm

For the last 12 to 18 months, the private technology market has seen sky high valuations and a significant disconnect from the public markets. Recently, much talked-about startup Slack raised $120M at a $1.12B valuation with just $1M in monthly revenue. My friend, Danny Crichton, wrote a really insightful piece on TechCrunch regarding this new trend of “fundraising acceleration”.

Crichton outlines the factors that have created such a fundraising strategy and also carefully points out the disadvantages of raising too much at too high a price. Namely, he highlights the increasing bifurcation of the have’s and have-not’s (high and low-growth companies, respectively), as well as consequences with equity compensation for employees.

Here are some pitfalls I see with this kind of investment strategy:

  • High risk of a down round: Macro conditions are nearly impossible to predict. Unless the mega round is meant to fully fund a company from one bull cycle to another, it’s likely that the next funding round will be a difficult one.
  • Capital inefficiency: This type of fundraising strategy is also counter-intuitive to the lean startup philosophy. Raising such a large amount of capital creates negative incentives to be capital efficient, and in the hands of an un-experienced team, can lead to higher burn rates.
  • Increased execution pressure: With a valuation so far beyond fundamentals, management teams will and should feel an increased pressure to perform. It’s no longer enough strive to deliver on a vision you’ve sold because you’ve already committed to deliver it. Traditional “Plan B” options, such as acqui-hires, will become harder to sell to the board.
  • Diminishing returns: The reason that market leaders are often rewarded by an order of magnitude is that idea that in a networked world, winners take most (if not all). With funding acceleration, VC’s are not only increasing the risk of betting on the right horse, but also driving down their own gains. As the adage goes, capital flows into an asset class until returns revert to the mean. When that happens for the VC asset class, it’ll be a painful day for those holding such over-valued assets in their portfolios.

Crichton also writes, 

The person who most popularized this notion of investing was Marc Andreessen (who ironically also happens to be one of the earlier investors in Slack), as well as Peter Thiel, whose experience with Facebook’s growth encouraged his investment thesis for Founders Fund.

While I’m a big fan of both, we should also consider the fact that neither of these two investors have long enough tenures as VC’s to have experienced a downturn in the markets, and more specifically, a downturn within the technology sector.

Silicon Valley’s Youth “Problem”: A Rebuttal

By now Yiren Lu’s “Silicon Valley’s Youth Problem” has made it way around both my personal and professional circles. As a young person living and working in Silicon Valley, I felt a strong sense of resentment after reading the article. The author focused on specific and superficial examples to build a case against many of the talented founders and engineers I know, and thereby, completely missed what makes Silicon Valley great. 

In the section titled “Unhappy Valley”, Lu outlines a phenomenon that the layman knows as FOMO: Fear Of Missing Out. But it’s not just a “Silicon Valley problem”, but a symptom of our generation as a whole. Sure, FOMO could make us feel like we’re trapped a giant hamster wheel, forever playing catch-up to the Jones. Every generation has a certain amount of FOMO, and given the speed of information today, our generation just feels it that much stronger. I think of FOMO instead as part of the reason why technology cycles have shortened and innovation has accelerated.

The article also questions whether today’s Silicon Valley has created anything of value. To be fair, many of the buzziest startups are consumer-oriented ones, and the value of a Facebook, Snapchat, or Twitter is undoubtedly tied to ad dollars. Money talks, and naturally, VC’s will continue to fund startups with advertising business models because the advertising market is enormous. Instead of asking whether Valley startups are doing anything worthwhile, shouldn’t the question be instead, what good does advertising do for society? By the same token, the author also discounts the importance of startups such as Uber and Airbnb, who have not only provided an additional revenue stream for thousands of people worldwide, but have also fundamentally changed some of the ways that humans interact.

Naturally, Silicon Valley will always have a so-called “Youth Problem”. Startups are risky, and by and large, younger people will have a higher risk tolerance. That doesn’t mean that substantial valley startups, like Dropbox and Stripe, are not striving to recruit tech veterans in leadership positions (in this example, former Motorola CEO Dennis Woodside and former Google executive Claire Johnson, respectively). Startups, especially venture-funded ones, do not have the hubris to believe that inexperienced 20-somethings are equipped to run billion-dollar businesses on their own.

Perplexingly, the author also tries to paint some of the most positive externalities of Silicon Valley in a poor light, for example, the democratization of tech and the consumerization of the enterprise. Isn’t it great that today’s teenagers, with just a conceptual grasp of computer science, could build an app for his/her own use and/or entertainment? Shouldn’t we support the notion of making enterprise applications easier to implement and more user friendly?

Most importantly, I’ve always believed that the most innovative companies are not necessarily apparent at first. One very prominent example of this is Google, a startup founded by two 23-year-olds in a garage at a time when there were already several search engines on the internet. (Maybe yesterday’s search engine is today’s texting app?) Larry Page, in a recent interview, spoke about grander ambitions for Google:

Even Google’s famously far-reaching mission statement, to “organise the world’s information and make it universally accessible and useful”, is not big enough for what he now has in mind. The aim: to use the money that is spouting from its search advertising business to stake out positions in boom industries of the future, from biotech to robotics.